Features and Benefits of Small-Cap Mutual Funds in India
Posted on 16-May-2024
6 min read
Small-cap mutual funds have become an attractive option for investors in India due to their multiple features and perks. Join Shriram AMC to learn more about them in this article.
Table of Content
There are different ways to classify mutual funds—by investment objectives, asset classes, management style, and structure, to name just a few. And we have, on purpose, missed out on including perhaps one of the most important kinds of classifications to transition seamlessly into our discussion. And that is classification by market capitalization.
What is it? It’s when you classify the funds based on the market cap of stocks that constitute the fund. And based on that, we have large-cap, mid-cap and small-cap. What we are going to talk about in this blog post are small-cap mutual funds.
So, let’s dig in!
These companies rank below 250th in terms of market capitalization, according to the Securities and Exchange Board of India (SEBI). SEBI also mandates that Small Cap Mutual Funds invest at least 65% of their total assets in these small-cap companies.
Investment Focus: Small-cap funds invest a minimum of 65% of their assets in small-cap stocks. The remaining portion can be invested in larger companies for diversification or to manage risk.
High Growth Potential: Small companies have ample room for growth, and their stock prices can potentially surge significantly if their business takes off.
Higher Volatility: Compared to large-cap or mid-cap funds, small-cap funds are more volatile. Their stock prices can fluctuate dramatically based on company performance and market sentiment.
Active Management: Small-cap fund managers play a crucial role in selecting promising companies with strong growth prospects. Their expertise in research and analysis is essential for navigating small-cap space.
So, you see, small-cap funds are not for investors who want to play it safe when it comes to risk. If you are willing to take up risks and are not easily swayed by market fluctuations, these funds could be a great way to (probably!) build wealth.
By understanding the features, and the mechanism of small-cap mutual funds, you can make an informed decision about whether they align with your investment goals and risk tolerance.
However, if you are not too keen on delving into the dynamic of how these funds work, sit tight and let Shriram AMC do the work for you.
High Returns: Historically, small-cap funds have delivered superior returns compared to large-cap or mid-cap funds. This is due to the high growth potential of the underlying companies.
Diversification: Adding a small-cap fund to your portfolio can help diversify your holdings and reduce overall risk. Small companies often operate in different sectors than established players, offering exposure to new growth areas.
Undervalued Gems: Small-cap companies often fly under the radar, and their stocks may be undervalued. Skilled fund managers can identify such hidden gems and unlock their potential for investors.
Merger and Acquisition Opportunities: Smaller companies are attractive targets for mergers and acquisitions by larger firms. This can lead to a significant increase in the stock price of the small company if it's acquired.
In simple terms, if you are smart enough to pick the right stocks, or the right fund house like Shriram AMC, adding small-cap funds to your portfolio can be a great opportunity to build wealth.
(If you were thinking, we’d say “great opportunity to getting rich,” that might be stretching it too far. Mutual funds are not a guaranteed ticket to abundant wealth. They are just a smart investing avenue for investors who want to “grow their wealth” steadily.)
Investment Horizon: Small-cap funds are suitable for investors with a long-term investment horizon (ideally 5-10 years or more) due to their inherent volatility.
Risk Tolerance: Small-cap funds are riskier than large-cap or mid-cap funds. Investors should have a higher risk tolerance to stomach potential fluctuations in their investment value.
SIP (Systematic Investment Plan): Investing in small-cap funds through a Systematic Investment Plan (SIP) can help average out the cost of investment and ride out market volatility.
Volatility: Be prepared for significant ups and downs in the value of your investment.
Investment Tenure: Stay invested for the long term to benefit from the growth potential of small companies.
Fund Management: Choose a small-cap fund with a proven track record and a skilled fund manager.
Cost Ratio: Pay attention to the expense ratio of the fund, as higher fees can eat into your returns.
Check the Liquidity Ratio: CRISIL assigns liquidity scores to mutual funds based on how quickly their holdings can be sold without impacting the price. Lower scores indicate higher liquidity.
Carefully consider your financial goals, risk appetite, and investment timeframe before diving into the exciting world of small-cap stocks. Remember, thorough research, choosing a well-managed fund, and potentially seeking professional financial advice can be instrumental in navigating this dynamic asset class and maximizing your chances of success.
1. Are there any tax benefits associated with small-cap mutual funds?
Yes, small-cap funds offer some tax advantages compared to directly investing in stocks. Equity mutual funds held for over one year qualify for long-term capital gains tax, which is generally lower than the tax on short-term gains. Additionally, dividends received from small-cap funds within the fund are reinvested, and you only pay taxes on dividends when you redeem your investment.
2. Can I invest in small-cap funds through international investment platforms?
Yes, depending on the platform and regulations in your country, you might be able to invest in Indian small-cap funds through international platforms. However, there could be additional fees and tax implications to consider. It's crucial to research and understand these factors before investing through international platforms.
3. How do small-cap funds compare to small-cap ETFs (Exchange Traded Funds)?
Small-cap mutual funds and ETFs both offer exposure to small-cap stocks. However, mutual funds are actively managed by fund managers who select stocks based on their analysis, while ETFs passively track a specific index. Mutual funds might offer potentially higher returns due to active management, but also carry higher fees. ETFs generally have lower expense ratios but may not outperform the market as much.
4. What are some red flags to watch out for when choosing a small-cap mutual fund?
Keep your eyes peeled for these warning signals when choosing a small-cap mutual fund:
High turnover ratio: A high turnover ratio indicates frequent buying and selling of stocks within the fund, which can lead to higher costs for investors.
Limited track record: A new fund manager or a fund with a short history might require more scrutiny before investing. Look for funds with a proven track record and a consistent investment philosophy.
Unrealistic expense ratios: While some actively managed small-cap funds might justify higher expense ratios due to potential outperformance, excessively high fees can erode your returns.
5. Are there any alternative investment options to consider alongside small-cap mutual funds?
Depending on your risk tolerance and investment goals, you might consider:
Mid-cap mutual funds: Offer a balance between growth potential and risk compared to small-cap funds.
Sector-specific funds: Focus on specific sectors with high-growth potential, but also carry higher concentration risk.
Index funds: Provide broad market exposure and lower fees but might not offer the same level of potential high returns as small-cap funds.
What is it? It’s when you classify the funds based on the market cap of stocks that constitute the fund. And based on that, we have large-cap, mid-cap and small-cap. What we are going to talk about in this blog post are small-cap mutual funds.
So, let’s dig in!
What is Small Cap Mutual Funds?
Small-cap funds are a type of equity mutual fund that primarily invests in stocks of companies with a lower market capitalization. In India, SEBI (Securities and Exchange Board of India) classifies companies with a market capitalization below Rs. 5,000 crores as small-cap. These companies are typically younger, high-growth businesses with the potential to become future market leaders.These companies rank below 250th in terms of market capitalization, according to the Securities and Exchange Board of India (SEBI). SEBI also mandates that Small Cap Mutual Funds invest at least 65% of their total assets in these small-cap companies.
What Are the Features of Small-Cap Equity Funds?
Before you decide to invest in small-cap funds, you need to understand what exactly they offer:Investment Focus: Small-cap funds invest a minimum of 65% of their assets in small-cap stocks. The remaining portion can be invested in larger companies for diversification or to manage risk.
High Growth Potential: Small companies have ample room for growth, and their stock prices can potentially surge significantly if their business takes off.
Higher Volatility: Compared to large-cap or mid-cap funds, small-cap funds are more volatile. Their stock prices can fluctuate dramatically based on company performance and market sentiment.
Active Management: Small-cap fund managers play a crucial role in selecting promising companies with strong growth prospects. Their expertise in research and analysis is essential for navigating small-cap space.
So, you see, small-cap funds are not for investors who want to play it safe when it comes to risk. If you are willing to take up risks and are not easily swayed by market fluctuations, these funds could be a great way to (probably!) build wealth.
How Does a Small Cap Mutual Fund Work?
Small-cap mutual funds pool money from investors and invest it in a basket of small-cap stocks. The fund manager actively researches and selects companies with high growth potential. The performance of the small-cap fund is directly linked to the performance of the underlying stocks in its portfolio. When the stock prices of the companies in the fund increase, the Net Asset Value (NAV) of the fund goes up, and investors earn returns.By understanding the features, and the mechanism of small-cap mutual funds, you can make an informed decision about whether they align with your investment goals and risk tolerance.
However, if you are not too keen on delving into the dynamic of how these funds work, sit tight and let Shriram AMC do the work for you.
Benefits of Investing in Small-Cap Mutual Funds
Don’t let the volatile nature of small-cap mutual funds scare you or push you away from investing. They do brag of some amazing benefits that could pique the interest of any investor. Check them out here:High Returns: Historically, small-cap funds have delivered superior returns compared to large-cap or mid-cap funds. This is due to the high growth potential of the underlying companies.
Diversification: Adding a small-cap fund to your portfolio can help diversify your holdings and reduce overall risk. Small companies often operate in different sectors than established players, offering exposure to new growth areas.
Undervalued Gems: Small-cap companies often fly under the radar, and their stocks may be undervalued. Skilled fund managers can identify such hidden gems and unlock their potential for investors.
Merger and Acquisition Opportunities: Smaller companies are attractive targets for mergers and acquisitions by larger firms. This can lead to a significant increase in the stock price of the small company if it's acquired.
In simple terms, if you are smart enough to pick the right stocks, or the right fund house like Shriram AMC, adding small-cap funds to your portfolio can be a great opportunity to build wealth.
(If you were thinking, we’d say “great opportunity to getting rich,” that might be stretching it too far. Mutual funds are not a guaranteed ticket to abundant wealth. They are just a smart investing avenue for investors who want to “grow their wealth” steadily.)
How Should You Invest in a Small-Cap Mutual Fund?
Investing in small-cap mutual funds is just regular mutual fund investing, and the ropes are all the same. You need to pick the right stocks or let your fund manager handle it for you, assess your risk tolerance and begin. Check out these steps for more insight:Investment Horizon: Small-cap funds are suitable for investors with a long-term investment horizon (ideally 5-10 years or more) due to their inherent volatility.
Risk Tolerance: Small-cap funds are riskier than large-cap or mid-cap funds. Investors should have a higher risk tolerance to stomach potential fluctuations in their investment value.
SIP (Systematic Investment Plan): Investing in small-cap funds through a Systematic Investment Plan (SIP) can help average out the cost of investment and ride out market volatility.
Factors to Consider Before Investing in Small-Cap Mutual Funds
Always keep these few factors at the back of your mind before choosing a small-cap fund:Volatility: Be prepared for significant ups and downs in the value of your investment.
Investment Tenure: Stay invested for the long term to benefit from the growth potential of small companies.
Fund Management: Choose a small-cap fund with a proven track record and a skilled fund manager.
Cost Ratio: Pay attention to the expense ratio of the fund, as higher fees can eat into your returns.
Check the Liquidity Ratio: CRISIL assigns liquidity scores to mutual funds based on how quickly their holdings can be sold without impacting the price. Lower scores indicate higher liquidity.
Parting Words
Small-cap mutual funds offer a compelling proposition for investors seeking high growth potential. However, they come with inherent volatility and require a long-term investment horizon and a higher risk tolerance.Carefully consider your financial goals, risk appetite, and investment timeframe before diving into the exciting world of small-cap stocks. Remember, thorough research, choosing a well-managed fund, and potentially seeking professional financial advice can be instrumental in navigating this dynamic asset class and maximizing your chances of success.
FAQs
Here are a few frequently asked questions about small-cap mutual funds in India:1. Are there any tax benefits associated with small-cap mutual funds?
Yes, small-cap funds offer some tax advantages compared to directly investing in stocks. Equity mutual funds held for over one year qualify for long-term capital gains tax, which is generally lower than the tax on short-term gains. Additionally, dividends received from small-cap funds within the fund are reinvested, and you only pay taxes on dividends when you redeem your investment.
2. Can I invest in small-cap funds through international investment platforms?
Yes, depending on the platform and regulations in your country, you might be able to invest in Indian small-cap funds through international platforms. However, there could be additional fees and tax implications to consider. It's crucial to research and understand these factors before investing through international platforms.
3. How do small-cap funds compare to small-cap ETFs (Exchange Traded Funds)?
Small-cap mutual funds and ETFs both offer exposure to small-cap stocks. However, mutual funds are actively managed by fund managers who select stocks based on their analysis, while ETFs passively track a specific index. Mutual funds might offer potentially higher returns due to active management, but also carry higher fees. ETFs generally have lower expense ratios but may not outperform the market as much.
4. What are some red flags to watch out for when choosing a small-cap mutual fund?
Keep your eyes peeled for these warning signals when choosing a small-cap mutual fund:
High turnover ratio: A high turnover ratio indicates frequent buying and selling of stocks within the fund, which can lead to higher costs for investors.
Limited track record: A new fund manager or a fund with a short history might require more scrutiny before investing. Look for funds with a proven track record and a consistent investment philosophy.
Unrealistic expense ratios: While some actively managed small-cap funds might justify higher expense ratios due to potential outperformance, excessively high fees can erode your returns.
5. Are there any alternative investment options to consider alongside small-cap mutual funds?
Depending on your risk tolerance and investment goals, you might consider:
Mid-cap mutual funds: Offer a balance between growth potential and risk compared to small-cap funds.
Sector-specific funds: Focus on specific sectors with high-growth potential, but also carry higher concentration risk.
Index funds: Provide broad market exposure and lower fees but might not offer the same level of potential high returns as small-cap funds.
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